Think about the last time you were in the grocery store choosing vegetables. Some of them seem rather expensive, don’t they? If you’re like me at all, you think “Gee, y’know, I could grow this in my back yard and get them for almost nothing!” The tomatoes, for instance. When I was a kid, my mother always had tomato plants in the summer that produced what seemed like bushels of tomatoes, all for the price of a few plants. One year, she even started the tomato plants from seeds and really saved a bundle!
But, alas, these days, I just don’t have the green thumb needed to raise a productive vegetable garden. That specialized knowledge has eluded me, or at least the desire to acquire that knowledge has eluded me. It’s not something I enjoy doing for very long. I don’t have a passion for it, or a need for it.
It boils down to this question. Do I want to pay for the seed or do I want to pay for the crop? In this case, I’ve “decided” to pay for the crop at the higher prices because I don’t have the specialized knowledge to pay for the seed and gain the crop at a later time.
There’s a similar question that can be asked when trying to decide whether to go with a Traditional IRA or a Roth IRA. To be sure, there are a number of good questions to ask when trying to decide between a Traditional and a Roth:
Do I need the deduction now?
Can I afford to pay the taxes on the contribution amount now?
What Tax Bracket am I in now vs. the one I’ll be in when I retire?
What do I anticipate my asset base will be when I retire?
But here’s the question of the day:
Do I want to pay taxes on the Seed (the IRA contributions) or the Crop (the distributions at retirement)?
This can be a very important consideration to someone who has specialized knowledge in an investment vehicle that could consistently earn the investor significantly higher than average returns than you might find with a diversified portfolio of stocks, bonds, and mutual funds. And this points to one of the other questions above: What do I anticipate my asset base to be when I retire?
If you anticipate your asset base growing to be significantly higher than the sum total of your contributions over the years, you may want to think about setting up a Roth IRA instead of a traditional IRA. For a Roth, only the contributions are taxed. When it comes time to distribute funds from a Roth IRA, they are distributed tax free.
Now, say over 30 years, you’ve contributed a total of $150,000 to your IRA, and because of your specialized knowledge, of Real Estate investing, perhaps, that your IRA grows to over $2,000,000. Which would you rather pay the taxes on, $150,000 or $2,000,000?
Guess what? The answer is not nearly as straightforward as you might think. Think about this for a day or so, and I’ll be back soon to run an analysis in my next post.
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Great post, Paul. Looking forward to your next one.